Trade war de-escalation improves growth outlook
China and the US have announced a significant reduction in reciprocal tariffs. The much-anticipated US-China trade talks concluded with "substantial progress" in reducing bilateral reciprocal tariffs, which is more positive than many had expected. China and the US both lowered the "reciprocal" tariff rate from 125% to 10%, suspending 24% of the 34% reciprocal tariffs imposed on April 2 for an initial period of 90 days and removing all escalation tariffs imposed thereafter. Both sides will establish a mechanism to continue discussions and conduct working-level consultations on economic and trade issues.
The 20% additional US tariff related to fentanyl control and Section 232 sectoral tariffs on steel, aluminum, and auto products remain in place. After such de-escalation, we estimate that the weighted average incremental tariff rate (ad valorem) that the US has placed on Chinese goods in 2025 is around 30% as of now, compared to around 96% before the de-escalation. Adding the pre-existing average tariffs from the Trump and Biden administrations, the total weighted average US tariff rate on China now stands at around 43.5%.
Smaller shock of tariff hikes on China's economy, with high uncertainty
There is still high uncertainty around the future US-China trade negotiations in the coming 90-day pause period and beyond, given the substantial differences between China and the US on some fundamental issues.
On the positive side, some of the fentanyl-related 20% additional tariff may be rolled back, and/or the 24% pending reciprocal tariff may be suspended for longer. On the negative side, there may be some notable back-and-forth in US additional tariffs in the coming months (including adding back some of the 24% pending reciprocal tariff), as happened during the previous trade war in 2018-19.
If the current 20% "fentanyl tariffs" and 10% "reciprocal tariffs" are in place without further escalations in the next 3-4 quarters, we estimate that such tariff hikes may pose a drag on China's GDP growth that is smaller than our previous baseline estimates, in which we assumed the 20% + 125% tariff hikes would last for longer. Similarly, China's total export growth is likely to be better than our previous projections in 2025.
Additional policy stimulus may be more modest than previously expected
The recent de-escalation of US-China trade tensions will likely reduce the potential scale of additional fiscal stimulus in the rest of 2025. In the case of 20% "fentanyl tariffs" + 10% "reciprocal tariffs," China may only ramp up new broad fiscal expansion by another less than 1% of GDP, versus the 1.5%-2% we assumed in our previous baseline, on top of the planned fiscal stimulus at the NPC meeting.
The timing of new fiscal stimulus may also be later than our previous projection of early Q3. As we discussed before, additional fiscal support could be used to 1) alleviate the impact on exporters and manufacturers suffering from the shock, 2) support local government finances and infrastructure spending, 3) expand the consumption trade-in programs further and roll out new support measures, and 4) increase social spending and subsidies to the household sector (including those for childcare and childbirth).
We continue to expect the government to push for more progress in property inventory destocking, given the renewed weakness of the housing market in April. We also continue to expect the PBC (the People's Bank of China) to cut policy rates by another 20-30bp in the rest of 2025 after its earlier 10bp cut in May, amid heightened uncertainties.
China's GDP growth in 2025 may improve
The trade war de-escalation may lead to a smaller shock on China's exports and economic growth, as well as more modest additional policy stimulus in the rest of 2025. Lingering uncertainties may continue to weigh on corporate confidence and capex plans, while front-loading of export shipments to the US may continue in the 90-day pause period.
We now think that China's real GDP growth depends on the ultimate format of US additional tariffs on Chinese goods and the actual scale of additional policy stimulus. The RMB may move in the range of 7-7.5 against the USD throughout 2025 (no major movements in either direction), with a bias towards the stronger end thanks to trade war de-escalation.
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